Demand

Demand. Demand is the quantity of a good or service that a consumer is willing and able to buy at the market price in a given time period.

Movement Along the Demand Curve

A demand curve shows the price a consumer is willing and able to pay for each quantity demanded. Market demand is the sum of all the individual demands from consumers in a market. The Law of Demand: An inverse relationship exists between price and quantity demanded. As the price of a good falls, quantity demanded rises, ceteris paribus. So the demand curve slopes down.

Note that demand is ‘effective demand’. A consumer’s want is not an effective demand, the consumer’s want must be backed up by income for it to be an effective demand.

As price falls, quantity demanded rises because of two effects:

1) The Income Effect. As price falls, the consumer’s disposable income rises, consumers have the ability to buy more so quantity demanded rises.

2) The Substitution Effect. As good X’s price falls, X becomes relatively cheaper than all other goods, so the quantity demanded of X increases.

Movement/Shift of the Demand Curve

An increase (decrease) in demand causes the demand curve to shift right (left). At each price there is a higher (lower) quantity demanded.

Many factors cause demand to change:

1) Income. An increase in income means consumers have the ability to buy more goods/services, so the demand curve shifts right.

2) Preferences/Tastes. Advertising and fashion (bad publicity) influences the choices consumers make and causes the demand curve to shift right (left). Advertising and fashion makes a consumer want a good more, so they will demand more of it. Bad publicity makes the consumer want the good less so they will demand less of it.

3) Population. An increase (decrease) in the economy’s population means more (less) people are demanding a good so the demand curve shifts right (left). The composition of the population also affects demand for goods. More babies mean an increase in demand for bottles and baby food.

4) Substitutes. Substitutes are alternative or replacement goods that satisfy similar wants (for example, Milky Way and Mars chocolate bars, Coca Cola and Pepsi, Ford and Audi cars, tea and coffee). Assume goods X and Y are substitutes. If the price of Y falls (rises), Y has become cheaper (dearer) relative to X, consumers substitute away from the more expensive good, so consumers demand more (less) of Y and less (more) of X. There is a movement along Y’s demand curve to the right (left), and the demand for X will shift to the left (right).

5) Complements. Complements are goods that are bought (usually) to be used together (for example, tea and sugar, cars and petrol, cheese and bread). Assume goods X and Y are complements. If the price of Y falls (rises), consumers buy more (less) of Y and will thus buy more (less) of X. There is a movement along Y’s demand curve to the right (left), and the demand for X will shift to the right (left). If the price of cars falls, ceteris paribus, cars are now cheaper, consumers will buy more cars and will buy more petrol to drive the cars, so there is a movement along the demand curve for cars to the right and the demand curve for petrol will shift to the right.

6) Interest Rate. An increase (decrease) in interest rates mean the cost of borrowing rises (falls) so consumers will demand less (more) goods that are usually bought on credit so the demand curve shifts left (right). Goods usually bought on credit include houses, cars and TVs. Also, the demand curve shifts left (right) because a higher (lower) interest rate means the return on saving is higher (lower) so consumers are incentivized to save more (less) and consume less (more). Additionally, higher (lower) interest rates cause demand to shift left (right) because consumers’ existing debt increases (decreases) so their disposable income falls (rises).

7) Direct Taxation. A direct tax is a lump-sum tax income (income tax). A rise in income tax means disposable income falls, consumers cannot buy as much as before so demand shifts left.

8) Confidence/Expectations. As consumers become more confident (better expectations about the economy and their future income) they buy more goods so demand increases and shifts right.